Everyone will agree that there has been a whole bunch of residential development over the past several years with a lot of discussion lately about oversupply and the rent versus buy decision. In many urban markets such as New York, there is always demand for residential housing but the questions becomes: What type do you build?: Rental Or Condo. Josh Barbanel discusses this and other aspects of the changing market in Are There Enough Buyers to Go Around? [NYT]. I chime in on a couple of points as well.

As mortgage rates rise, condo buyers gradually drop out or are squeezed out and become renters as affordability diminishes. What pushed the demand side over the top in the recent housing boom was the movement of renters to buyers chasing low mortgage rates. Now the rental market is getting stronger at the expense of the purchase market.

What does a developer do in mid-construction with a new building when the market changes beneath their feet? Do they simply convert a condo development to a rental to chase these consumers? Not all developers have the luxury (no pun intended) of being able do whatever they want with a site as the market turns yet I hear this all the time as a fail-safe option by industry analysts.

The switch to rental seems to be the assumption of many as a viable option. It would seem to diminish the exposure of residential developers. If buyers go away, renters will appear. All is good.

Perhaps this is more possible in a rental to condo conversion since the development was often already configured as rental to begin with, but new construction is another story.

Quick, name a recent new construction residential project that was converted in mid-construction to rental.

Its difficult to come up with one.

Why?

Because the economics for the developer make it unlikely. Here are a few thoughts in no particular order:

  • The level of amenities for new condos in the latest housing boom is much higher than for rentals such as better soundproofing, larger room sizes and different common amenities.

  • The mix of apartments tend to be weighted toward larger units in a new condo.

  • Condo buyers came from rentals so the product is already designed as an upgrade to entice renters to move up.

  • There are many soft costs associated with the redesign of the development.

  • Condos are still selling, but at a slower pace. The economics of a longer marketing time to sell out a condo project versus a lower rental rental return may not make sense. Quite often, the condo option was the only one that could justify the land purchase price.

  • I often am told by developers and financial institutions that the financing on a particular project is not affected by rising rates (apparently I missed that financing course in college).

  • Land costs have risen so much that the project would have difficulty being economically feasible. The reason condos were built in the first place was because of their greater return to developers over rental. Land owners understand this. Developers who bought the land before the boom, would be more likely to make the switch.



One Response to “Urban Legend: Converting Newly Constructed Condos To Rentals”

  1. dave says:

    That’s true, you don’t often hear of buildings actually switching. But, wasn’t there one in Chelsea about 3 to 5 years agao? If so, could it be the exception that proves the rule? Silverstein has a site on W 42nd and 11th that is supposed to be rental. He excavated early this year but has done nothing since. I wonder, is he contemplating switching to condo and just waiting to see if the market will stay strong enough for that?